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What Exactly is an IR35? Here Are The Basics

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IR35 legislation was introduced by the Government in April 2000. It is designed to tax people deemed to be in 'disguised employment' at a rate similar to those in permanent employment. IR35 was introduced to avoid people leaving full time employment and then returning to the same job as a contractor, therefore reducing their tax and national insurance liability. All contractors who do not meet the Inland Revenues self-employment criteria are affected by IR35.

How it Works

The issue for contractors is whether or not their responsibility, liability and control is the same for permanent employees and if so they would fall under the IR35 legislation. Contractors would then have to pay full tax and National Insurance and would have reduced expense allowances.

What Exactly is an IR35? Here Are The Basics

The main factor with IR35 is to determine whether the contractor is employed or self-employed under HMRC's guidelines. Schedule E national insurance and taxation will have to be paid by those contractors liable to IR35. This will result in an increase in tax and national insurance liability and prevents contractor companies from retaining profits. Ultimately, it may be a good move to seek out specialist accounting to manage your IR35.

If a contractor falls under IR35, expenses under Section 198 are still eligible, as well as other expenses up to 5% of turnover. Therefore pension payments; professional indemnity cover; business travel; accommodation and meals; and benefits such as medical insurance can be claimed. If a contractor is found liable for IR35 legislation, it could still be possible to change working practices and use an IR35 'friendly' contract in order to avoid the legislation.

How to Avoid IR35

Essentially, in order to avoid falling foul of IR35 legislation, a contractor must satisfy the Inland Revenue's definition of self-employment. Inland Revenue will assess a contractor's role to determine whether or not they are seen to be self-employed in accordance with the rules of IR35.

All contractors must be seen to be self-employed for at least part of their income to be free from IR35 legislation. In order to do this the contractor could diversify their business interests or change working practices in order to satisfy more of the factors relating to self-employment. This will certainly strengthen the position in the context of IR35.

It is also important for the contractor to have a contract in alignment with IR35, with working agreements and physical arrangements that adhere with those defined in the contract.

Other means by which to avoid falling under IR35 legislation include contracting abroad. This would mean being taxed on a non-resident basis, as well as other potential gains such as cheaper accommodation. However, overseas tax legislation can be equally or more complex than domestic tax law.

Contractors could also become a permanent employee. This would appeal to any contractors who wish to feel more secure and avoid the uncertainty of IR35.

Many contractors do nothing to address the issue of IR35 in the belief that the legislation will be revoked, or they remain under the impression that it doesn't apply to them. IR35 is law and the Inland Revenue will investigate. If you are deemed to fall under IR35 legislation you will have to accommodate a significant increase in taxation liability.